Precipitous Reduction in Bank Reserve Requirements

09-06-2011 • Ritholtz.com

And one of the prime causal agents of this massive growth in borrowing, Alan relates, was the precipitous reduction in bank reserve requirements, from 12.3% in 1968 to 10.1% in 1978 and 8.5% in 1988. What that meant, he explains, was that the banks could lend 12 times their reserves, which, we might add, most of them lost no time in doing, and ultimately lived to regret it, except for those institutions that are no longer standing. A legacy of that barely credible rush to lend that bedevils us still, Alan laments, is that reserve requirements have become something of a meaningless statistic as banks push into more-lucrative businesses like the creation and sales of sophisticated derivative instruments “that no one truly understands” or, for that matter, has even a tenuous grasp of the attendant risks. And he points out, too, that banks now have gone whole-hog in high-frequency trading, which accounts for over 70% of turnover on the exchanges. And, we might add, is finally drawing more intense scrutiny by the often somnolent SEC. In short, increasingly, and one might say eagerly, banks have abandoned their traditional roles in favor of speculating. Crucial in enabling the banks to indulge their wayward activities was the 1999 repeal of the Glass-Steagal Act enacted in 1933 to prevent the banks from using the savings of widows, orphans and other innocent depositors as the coin to speculate with. One mind-boggling result cited by Alan of the banks becoming prey to the casino mentality is that dollar trading volume now weighs in at four times gross domestic product — that’s right, quadruple GDP — and up a full tenfold what it was from 1926 to 1999. We’ve become a nation of paper swappers.